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Remarks of
John E. Sheehan
Board of Governors
Federal Reserve System
before the
D.C. Bankers Association
June 9, 1972
Hot Springs, Virginia

P R O G R E S S



I hope that my remarks today will be helpful by contributing
something to your perspective on the current economic view.
going to begin with a brief appraisal of that picture.

I am

That appraisal

will lead to a conclusion I hold strongly and that I believe must
become the core of the nation's economic policy.
Let me state that conclusion now.

The finger of perspective

points, I think, at a need for high and rising productivity.


other members of the Federal Reserve Board, notably Chairman Burns,
have emphasized the need for increased productivity, let me note that
the views I am expressing today represent my personal opinions.
We w a n t — and as a nation our desires are expressed in the
Employment Act of 1946--high and rising income, maximum employment
of our human and natural resources and of our hard earned capital.
We want high and rising respect for the dollar in international trade.
This means that we want our goods and services to be competitive at
home and abroad, so that we can earn and keep a basic balance in our
international accounts.
We want to remake our cities.

We want to invent the first

society that offers everyone the opportunity to escape poverty without
And we want to satisfy all these needs and desires at low and
declining costs to the environment.

-2This is a requirement that we produce at lower unit cost
in terms of wear and tear on the environment.

Such a requirement

calls for added industrial and taxpayer outlays that are large and
long lasting.

W h e n we add that to the high consumption goals we

expect our production to meet, the need to produce at the highest
level of productivity we can sustain becomes as urgent as it is



Let me now add up to this conclusion, beginning with the
m ain elements of the current economic picture.
Industrial production is accelerating.

The Federal Reserve's

Index of Industrial Production rose sharply in April.
eighth successive monthly rise.

This was the

In the first four months of this

year, industrial production has risen at an annual rate of 9 per cent.
Employment is improving at a rate well above the long term

Approximately two and one-half million people were added to

civilian employment rolls from H a y 1971 through M a y 1972.


half this increase took place in the first five months of this year.
Despite this blooming of job opportunities, unemployment has
not yet dropped significantly, because the civilian labor force has
also grown at an unusually high rate, as it often does in periods of
increased job opportunities.
Thirdly, surveys and figures on new orders both show that
plant and equipment expenditure plans for the year are moving ahead



Last fall, for example, one leading survey suggested a

7 per cent increase in capital expenditures for 1972.

The most recent

of the surveys by that firm shows a 14 per cent growth projected for
the year.

In between the two, other surveys, also showed continuous

The most recent Commerce Department survey of capital spending
shows a 10.3 per cent increase for the year, however.

That these pro­

jections have been increasing since last fall appears to indicate
growing optimism among businessmen.
Finally, I would report that consumers are spending pretty
well from their growing incomes.
this year so far.

Retail sales have risen substantially

Car sales are strong--the rate for the last several

months has been about 9 million domestic sales and 1 1/2 million
imports— a good sales rate.

And car sales are normally thought to be

an unusually sensitive indicator of consumer attitudes.
Color television set sales have been excellent, and home fur­
nishing sales are especially strong.

In March, we had the largest

increase in consumer installment credit ever recorded and the April
increase also was substantial.
The only key indicator for which we do not yet have evidence
of a turnaround is inventory investment.

But, as a former manufacturing

company executive, I am confident that growing consumer purchases and
rising demands for business equipment will result in some inventory
build-up shortly.


Thus, the prospects for a good solid growth in Gross National
Product for the year are excellent.

And the $100 billion consensus

forecast may prove low.
As these growth factors continue to operate, w e can reasonably
expect unemployment to drop.
There is an irony hidden in this record of achievement.


growth so far in 1972 has occurred without the massive degree of
fiscal stimulus that was expected to beget it.

An unexpected over­

withholding of income taxes— on the order of $8 billion at annual
rates so far--has been the main factor in cutting the current budget
deficit from the nearly $39 billion previously announced to some
$26 billion announced in the mid-year budget review this week.
review also raised the fiscal 1973 deficit to some $27 billion.


1972 evolves and we turn the corner into 1973, and fiscal stimulus
plus inventory building occurs, the pace of economic activity can be
expected to strengthen further.

The problem for policymakers in the

first half of 1973, then, will consist in a strong economy, little in
need for further stimulus, but getting it from continued substantial
Federal deficit spending— assuming that the projected Federal deficit
ensu e s .
Thus, we appear to be moving into a period of quite substantial
growth in the American economy.

The problem for policymakers will be

to sustain and encourage that growth while continuing to moderate the
dangerous inflation we have been experiencing.

We shall have to



become conscious again of "demand-pull" inflation dangers, and find
a narrow path between that threat and the "cost-push" inflation that
has been the danger in the last two years.



Some complain that Phase II controls are not working well

While I agree that the inflation we have suffered in recent

years has been particularly stubborn, I do not believe it is appro­
priate to compare, say, the rate for the second quarter of 1972,
which may be about 3 to 4 per cent, with the second quarter 1971 rate
of 5 per cent.
The more appropriate comparison would be a comparison of what
we have, with what could have been expected in the second quarter of
this year had no controls been applied.

As an until recently ma n u ­

facturing executive, I am aware of the squeeze rising costs in 1971
were applying to profits, and the impetus this was giving to price
President Nixon's program as implemented by the Congress took
much of the steam out of the price increases being foreordained by
the cost push of 1971.

Substantial volume gains in the meantime—

given the strength of the recent recovery— have bolstered total
profits even though controls have held down prices.
In this respect, let me add that one of the strong reasons
for believing that the economy is definitely mending is that business
profitability is improving.

- 6-

Corporate profits as a per cent of GNP in 1970 reached the
lowest level in about three decades.

In the intervening year and

more, corporate profits as a share of GNP have generally risen.


the ratio to GNP has not yet come anywhere near peaks reached earlier
in the post w ar period.
Some appear overly concerned now that the recovery over the
near term is too strong.

I have noted my consciousness of possible

inflationary pressures in 1973.

But, I think the facts that we are

utilizing our manufacturing capacity at a rate of less than 80 per
cent currently in this country, and that we have a 5.9 per cent rate
of unemployment, do not suggest a need for choking off the stimulus
to investment and expansion.
I am concerned that pressures for an end to controls may end
their moderating influence prematurely.

I desire a return to the type

of economic freedom that has served us all so well for so long as much
as anyone could desire it.

But, in order for controls to be lifted

successfully, we need to experience, for a reasonable period, a rate
of inflation substantially less than we now have.



Earlier, I touched on growth of employment in recent months.
This generally satisfying growth record conceals a troublesome
element, not often highlighted.
in governmental employment.

That is the continuing sharp growth



While Federal Government civilian employment has held constant

the past twelve months--by dint of a special Administration effort—

state and local governments have added one in four of the jobs created
during that time.

As a factor tending to ameliorate a serious unemploy­

ment problem, this development is commendable.

But, as a long term

trend in this country, sharply rising government employment is, to me,
quite troublesome, for it underpins the rise of governmental spending at
all levels that has been on a steep curve of increase for many decades.
In 1940, there were 32.4 million people employed in nonagricultural establishments in this country and 4.2 million were in
government jobs at all government levels.

In 1971, there were 70.7

million people employed in non-agricultural establishments in the
United States and 12.9 million were in government.





From 1947 through 1967, Federal Government expenditures
approximately doubled each decade.

When the price inflation is taken

out of these numbers, we still find an increase of 3 1/2 times over
the two decades.

And if the rate of increase in the five years since

1967 is projected through 1977, there would be another one-decade
More bothersome still, total expenditures by governments
(State, local and Federal) have far outpaced the growth in the private
sector of our economy in recent decades.

Governmental expenditures

were about 1 per cent of our Net National Product in 1929 while in
1971 they were about 36 per cent.*
It appears to m that one of the major short and long term
problems in this country is to moderate the growth in governmental
expenditures at a ll levels.
The short term aspect of this problem relates to the apparently
unneeded fiscal stimulus which m well occur in the first half of
The long term problem is also a severe one.

While the

pressure for increased public expenditures and consequent tax increases
seems inexorable, that pressure must be successfully resisted.
There are those, nevertheless, w suggest that we are miserly
about expanding governmental expenditures in this country.

And com

parisons are drawn between the United States and Western European
countries such as Sweden and England where higher proportions of
gross national product are dedicated to the public sector.

In m

view, this would seem to be the wrong way to judge this problem.
I do not think any specific share of G P devoted to public
expenditure is the right proportion for a ll time and for a ll countries.
But an increasing ratio of public expenditure to G P carries with it
the risk of reducing the potential long-run growth rate of the economy.
Too often, the public is not prepared to decrease private consumption
*Net National Product defined as the value of newly produced goods
and services after allowance is m
ade for the value of capital goods
used up in their production.


to finance an increased use of resources by the public sector, so
that government absorbs resources that would otherwise go into the
capital formation needed for economic progress.

Also, when rising

governmental expenditures stem from programs that redistribute
income, the effects on the tax structure may dull incentives to the
point where individual initiative suffers.






This brings us to the heart of the matter.

We have been

rapidly losing our competitive posture in world markets because our
costs— primarily labor— have gotten out of hand.
In recent yeaxs, productivity has increased only minutely in
this country, although we did get a 3 1/2 per cent rate of increase
in 1971 in the private non-farm sector.

In the first quarter of 1972,

the rate was a little more than 3 1/2 per cent, but compensation per
man hour went up over 9 per cent, and unit labor costs increased
about 5 1/2 per cent.
The first quarter was somewhat unusual, in that the large
increase in compensation per man hour reflected the bulge in wage
rates after the freeze.

We can probably expect productivity increases

of about 4 per cent or so in later quarters of 1972.

If compensation

per man hour were to increase by more than that, unit labor costs
would continue to rise.
In my experience as a manufacturing company manager, I
found that unions often resist increases in productivity while

-10demanding continuous wage increases, although there have been
notable exceptions.

But, union leaders must understand--as each

American m u s t — that real income can rise only to the extent that
men produce more.

There is a simple equation that we must all live

with: if we are to consume more per capita, we must produce more
per capita.
Furthermore, it has often seemed relatively easy to manage­
ment to raise prices enough to hold profit margins in the face of
increased wages.

What is truly difficult is to lower costs sharply

through increased productivity.

But, it can be done, and a firm

relationship of increases in wage rates to gains in productivity is
essential if we are to regain price stability.
Few realize that for a hundred years during the early history
of this country— except for war time periods— prices generally fell.
This sometimes occurred only at social costs not now acceptable.
The point is that no such social costs must be levied in the name of
price stability if we make greater productivity the password to higher
wage rates.
In two relatively large manufacturing facilities which were
part of m y responsibility in recent years, we found through exhaustive
studies that if the plants were removed to another location--almost
any location--the work force could be reduced about 40 per cent. Decades
of history in those plants with work rules and labor practices which
severely limited output precluded all but modest productivity improve­
ments over the short term.


High costs and low productivity are not confined to the factory

Many of our corporate management structures could be pruned

to good effect.

I endorse Peter Drucker's conclusion:

"There is not

one company I know of where a sharp cut in the number of executives
would not be a real improvement.

They are all grotesquely over

There are few companies familiar to me that could not lower
their overall costs by at least 10 per cent, and as much as 25 per
cent or more, if two ingredients were present:
--a management with the will to manage
— a willing, cooperative work force
both of them understanding that income can increase in real terms only
as productivity rises.
The problem of increasing our national productivity is such
that I believe the time has come to embark upon a national crusade with
the same sense of urgency that President Kennedy displayed when he
launched our program to put men on the moon.
One of the more beneficial uses we can make of our tax powers
is the provision of incentives to modernize production methods.
Despite this, calls are now being heard to repeal the investment tax
credit, or reverse the trend toward liberalized depreciation allowances
initiated during the Kennedy administration.

This would, indeed, be

short sighted, in my view, tragically so.
Secretary of the Treasury Connaily recently observed that some
40 per cent of our factory equipment was obsolete.

In driving for

-12lower costs, for example, the Japanese are tearing out ste«l pro­
duction equipment we consider modern, in order to install larger
volume, lower cost units.
From 1960 to 1968, the U.S. economy devoted a much smaller
proportion of its total output to nonresidential fixed investment
than other leading industrial societies:

31 per cent


19 per cent


17 per cent

United States

13 per cent

Thus, those who urge less incentive to modernize the industrial
plant and equipment base of this country should appreciate two factors:
the declining efficiency of American plant and equipment as compared
to our competitors, and the growing importance of capital investment
in a nation whose economy must become increasingly sophisticated if
it is to continue to provide the income for the highest standard of
living in the world.
The real key then to the restoration of the American economy
to its old vigor lies in improving productivity at all levels and in
all segments.

And as productivity increases, salaries and wages should

rise and prices should be stable or should fall.
I propose that we target a 5 per cent increase in productivity
for each of the next five years.
We should set up management-worker-public productivity councils
at local levels throughout the country to eliminate absenteeism and


13 -

shoddy workmanship, and to lower costs sharply.

And the workmen must

be promised a substantial share of the proceeds of higher productivity.
Where workmen have been given their share, progress in many instances
has been remarkable.
We must think deeply about the fundamental reforms needed to
cause both wages and prices to respond to changes in demand and supply.
President Nixon has in the last few months set us upon the path
to new relationships and, I believe, healthier ones, with most of the
great powers of the world through the realignment of the dollar, his
call for fairer trade practices, his approach to the People's Republic
of China, and the series of watershed agreements he negotiated at the
summit in Moscow.
But, let us remember that we cannot follow through on these
promising initiatives if we present to the world, and present to
ourselves, a high rate of inflation and an economy ever less capable
of competing on an even basis with the many economic powers that are
on the rise throughout the world.

Greatness begins with soundness at

Insofar, at least, as our economy is concerned, greatness begins

with high rates of gain in productivity and the maintenance of wage
rate increases commensurate with productivity gains, so that prices
can remain stable.
The keystone is not the whole arch, nor the arch the whole
structure it supports.

Productivity is not the whole story.

arch will not stand without its keystone.

But the

And productivity gain is

the keystone to the economic progress we must have if we are to keep


our place in world affairs, providing the leadership the world seeks
and deserves and continuing to demonstrate that America provides
Americans with the highest quality life in the world.